Professional Documents
Culture Documents
M.COM.
SEMESTER - IV(CBCS)
PERSONAL FINANCIAL
PLANNING
Editor : Sreevallaban N
Assistant Professor
R. A. Podar College of Commerce
& Economic (Autonomous), Mumbai
Published by : Director,
Institute of Distance and Open Learning ,
University of Mumbai,
Vidyanagari, Mumbai - 400 098.
4. Investment Planning 85
Revised Syllabus of Courses of
Master of Commerce (M.Com) Programme at Semester IV
(To be implemented from Academic Year- 2022-2023)
No. of
SN Modules
Lectures
4 Investment Planning 15
Total 60
SN Modules/ Units
1 Understanding Personal Finance
Introduction
x Time value of money applications
x Personal financial statements, Cash flow and debt management, tools and
budgets
Money Management
x Tax planning
x Managing Checking and Savings Accounts
x Maintaining Good Credit
x Credit Cards and Consumer Loans
x Vehicle and Other Major Purchases
x Obtaining Affordable Housing
Income and Asset Protection
x Managing Property and Liability Risk
x Managing Health Expenses
2 Risk Analysis & Insurance Planning
x Risk management and insurance decision in personal financial planning,
x Various Insurance Policies and Strategies for General Insurance, Life Insurance,
Motor Insurance, Medical Insurance.
3 Retirement Planning & Employees Benefits
Retirement need analysis techniques, Development of retirement plan, Various
retirement schemes such as Employees Provident Fund (EPF), Public Provident
Fund (PPF), Superannuation Fund, Gratuity, Other Pension Plan and Post- retirement
counselling.
4 Investment Planning
Risk Return Analysis
Investing in Stocks and Bonds ,Mutual Fund, Derivatives, Investing in Real Estate,
Asset Allocation, Investment strategies and Portfolio construction and management.
1
UNDERSTANDING PERSONAL FINANCE
Unit Structure :
1.0 Objectives
1.1 Introduction
1.2 Time Value Of Money
1.3 Time Value Of Money Concept
1.4 Money Management
1.5 Income And Asset Protection
1.6 Exercise
1.0 OBJECTIVES
After reading this chapter learner will be able to:
1.1 INTRODUCTION
Personal Financial Planning (PFP) in India refers to the process of
managing an individual's financial resources to achieve financial goals and
objectives. PFP involves evaluating a person's current financial situation,
identifying their financial goals and objectives, and developing a
comprehensive plan to achieve those goals.
1
The process of PFP in India involves assessing the individual's income,
Personal Financial
expenses, investments, and debt, and then creating a plan to optimize their
Planning
financial situation. This plan may include strategies for budgeting, saving,
investing, tax planning, retirement planning, and risk management.
In India, PFP has become increasingly important as the country's economy
has grown and more individuals have become financially independent.
With a range of investment options available, including equities, bonds,
and mutual funds, there is a need for individuals to understand their
investment options and make informed decisions.
PFP in India is typically carried out by financial planners, who may be
certified by organizations such as the Financial Planning Standards Board
India (FPSB India) or the Association of Mutual Funds in India (AMFI).
These professionals help individuals make informed decisions about their
finances and develop a customized plan to achieve their financial goals.
PVIF= FV x
2
Where, Understanding
Personal Finance
PVIF = Present value of Interest Factor
FV = Future value
DF = Discounting factor
r = rate of return
n = time period in years
b. Present Value of Annuity Factor: This method is usedwhen there
is annuity payment which means payment of the same amount at regular
intervals.
PVAF=
Where,
PVAF= Present Value Annuity Factor
A = Annuity Factor or Periodic Payment
r = rate of return
n = time period in years
2. Future Value: A future value is the compounded value of a present
value.
There are two different approaches to calculate the futurevalue:
a. Future Value Interest Factor
FV = PV X CF
FV = PV x
Where,
FV = Future value
PV = Present value
CF = Compounding factor
r = rate of return
n = time period in years
FV =
3
1.2.2 Practical Application:
Personal Financial
Planning Illustration 1:A bank offers a return of 12% p.a. on the investment for a
period of 10 years. If you invest a sum of 12,00,000 in the scheme, how
much amount will be received by you?
FV = PV X CF
FV = PV x
FV = 12,00,000 x (1+0.12)10
FV = 12,00,000 x (1.12)10
FV = 12,00,000 x 3.1058
FV = 37,26,960
Illustration 2. What will an investor receive at maturity if he invests in a
scheme a sum of ` 5,000 annually at the end of the year for 9 years at
interest rate of 11% pa compounded annually?
FV =
FV =
FV =
FV =
FV =
FV =
FV = 70,818
Illustration 3. An investor wants to find out the value of an amount of `
1,00,000 to be received after 15 years. The interest offered by bank is 7%.
Calculate the PV of this amount.
PVIF= FV X DF
PVIF= FV x
PVIF= 1,00,000 x
PVIF= 1,00,000 x
PVIF= 1,00,000 x
PVIF= 1,00,000 x
PVIF= 36,240
4
Illustration 4. Mr Xavier has an investment proposal in which he has to Understanding
invest 38,950 every year for next 15 years which offers interest @ 9.5%. Personal Finance
What should be the present value of such investment?
PVAF =
PVAF =
PVAF =
PVAF =
PVAF =
Illustration 05:
Mr. Ram is investing in a scheme which offers the following returns in
next five year if he invests ` 55,000 today.
Year 1 2 3 4 5
The current return on the similar investment scheme is 10%. Please advise
whether Mr. Ram should invest in the scheme or not?
Solution:
Year 1 2 3 4 5
Since the Net Present Value is negative, it is advised to not invest in the
plan.
1.2.3 Applications of the time value of money in the context of
Personal Financial Planning:
1. Retirement Planning: The time value of money plays a critical role in
retirement planning, where individuals need to save enough money to
support themselves in retirement. By understanding the time value of
money, individuals can make informed decisions about how much to
5
save, where to invest their money, and when to start withdrawing
Personal Financial
funds from their retirement accounts.
Planning
2. Budgeting: The time value of money is also relevant in budgeting,
where individuals need to balance their income and expenses over
time. By understanding the time value of money, individuals can
prioritize their spending, allocate their resources effectively, and avoid
overspending.
6
1.3 TIME VALUE OF MONEY CONCEPT Understanding
Personal Finance
1.3 Personal financial statements, Cash flow and debt management,
tools and budgets
1.3.1 Personal financial statements:
Personal financial statements are documents that provide a summary of an
individual's financial situation. They typically include information on
assets, liabilities, income, and expenses.
These statements are used to assess an individual's financial health and to
determine their ability to manage their finances effectively. They can also
be used by lenders and financial institutions to evaluate an individual's
creditworthiness and ability to repay debt.
Personal financial statements can be prepared by individuals themselves,
or they can be prepared by professional accountants or financial advisors.
They are an important tool for individuals to use in creating a financial
plan and achieving their financial goals.
There are three main types of personal financial statements that
individuals can use to assess their financial health and plan for their
financial future:
3. Cash flow statement: A cash flow statement tracks the flow of money
into and out of an individual's accounts over a period of time, usually a
month or a year. It shows how much money is coming in, how much is
going out, and where the money is being spent. This can be helpful in
identifying areas where an individual can cut back on spending and
increase their savings.
7
1.3.2 Debt Management:
Personal Financial
Planning Debt management refers to the process of managing and controlling debt
to improve one's financial situation. It involves developing and
implementing a plan to pay off debt, reduce interest charges, and avoid
accumulating new debt.
Debt management typically involves analysing one's current debt
situation, creating a budget to ensure that there is enough money to pay
down debt, and prioritizing which debts to pay off first based on interest
rates and balances. It may also involve negotiating with creditors to reduce
interest rates or establish a more manageable payment plan.
The goal of debt management is to improve one's credit score and overall
financial health by reducing debt and avoiding late or missed payments. It
can help individuals achieve financial stability and avoid the negative
consequences of excessive debt, such as bankruptcy, foreclosure, or wage
garnishment.
3. Prioritize debts: Use your list of debts to prioritize which ones to pay
off first. Consider focusing on high-interest debts first, as they will
accumulate more interest over time and can be more costly in the long
run.
6. Stick to your debt repayment plan: Once you have a plan in place,
stick to it. Make your monthly payments on time and try to allocate
any extra funds towards debt repayment. It may take time, but sticking
to your plan will eventually lead to becoming debt-free.
8
Understanding
7. Avoid taking on new debt: While you are working on paying off your Personal Finance
existing debt, avoid taking on any new debt. This will only make it
harder to become debt-free and can lead to a never-ending cycle of
debt repayment.
Remember, debt management is a process that takes time and effort. But
by following these steps and staying committed to your debt repayment
plan, you can achieve financial freedom and improve your overall
financial well-being.
3. Balance transfer credit cards: Credit cards like the Chase Freedom
Unlimited or Citi Diamond Preferred offer introductory 0% APR
periods, allowing individuals to transfer high-interest credit card
balances and pay off debt interest-free. This can save individuals a
significant amount of money on interest charges. However, it's
important to pay off the balance before the 0% APR period ends, as
the interest rate will increase substantially after that.
8. Side hustles: Taking on a side hustle like freelance work, driving for
Uber, or selling items on eBay can help individuals earn extra income
to pay off debt faster. This can be a great way to accelerate debt
repayment and achieve financial freedom more quickly.
10
while a flexible budget includes expenses that can vary from month to Understanding
month, such as groceries or entertainment. Personal Finance
6. Reduce Debt: Paying off debt, particularly high-interest debt, can free
up cash flow and improve an individual's financial situation.
7. Save for Retirement: Saving for retirement early can help individuals
build wealth and achieve financial security in their later years.
8. Invest Wisely: Investing can help individuals grow their wealth over
time, but it is important to do so wisely, taking into account risk
tolerance and long-term financial goals.
11
10. Avoid Impulse Spending: Impulse spending can undermine financial
Personal Financial
goals and lead to unnecessary debt, so it's important to avoid it.
Planning
11. Use Banking and Financial Tools: Banking and financial tools, such
as mobile apps and online banking, can help individuals manage their
finances more effectively.
12
8. Managing Risk: Effective tax planning can help individuals manage Understanding
risk by identifying potential tax liabilities and taking steps to mitigate Personal Finance
them.
4. Use Online and Mobile Banking: Using online and mobile banking
services can help individuals manage their accounts more effectively,
such as checking balances, transferring funds, and paying bills.
13
9. Use Automatic Transfers: Setting up automatic transfers between
Personal Financial
checking and savings accounts can help individuals save more
Planning
effectively.
4. Loan Eligibility: CIBIL scores are often used by banks and financial
institutions to assess loan eligibility and determine interest rates.
3. Better Loan Terms: A good credit score may qualify borrowers for
better loan terms, such as longer repayment periods or lower fees.
10. Approval Odds: A good credit score can improve applicants' odds of
being approved for credit cards, loans, and other financial products.
15
11. Financial Stability: Maintaining a good credit score can help
Personal Financial
borrowers manage their debt, build savings, and achieve long-term
Planning
financial stability.
12. Credit Limits: With a good credit score, borrowers may be offered
higher credit limits on credit cards and other types of loans, providing
more financial flexibility.
4. Use Credit Cards Responsibly: Use credit cards for small purchases
and pay them off in full each month, rather than carrying balances.
7. Limit Credit Inquiries: Too many credit inquiries can harm credit
score, so limit credit inquiries to only necessary ones.
8. Keep Old Credit Accounts Open: Older credit accounts with good
payment history can improve credit score, so avoid closing them
unless absolutely necessary.
11. Avoid Settlements: Settling loans for less than the full amount owed
can harm credit score, so try to avoid settlements whenever possible.
16
12. Seek Professional Help: Consider seeking the help of a financial Understanding
advisor or credit counsellor if struggling to improve credit score or Personal Finance
manage debt.
3. Higher Credit Limits: Lenders are more likely to offer higher credit
limits to borrowers with good credit scores, which can help individuals
access more credit when needed.
17
1.4.4 Credit Cards and Consumer Loans
Personal Financial
Planning 1.4.4.1 Credit Card
A credit card is a type of payment card that allows cardholders to borrow
funds from a financial institution (such as a bank or credit card company)
up to a certain limit, to make purchases or withdraw cash advances. The
borrowed amount must be repaid with interest and fees, depending on the
terms of the credit card agreement.
Credit cards typically have a revolving credit line, which means that the
borrower can use the available credit, pay back the amount, and then reuse
the credit line as needed. Cardholders can also choose to make minimum
payments, which may result in carrying a balance and paying interest
charges.
Credit cards can be used to make purchases at physical or online
merchants, as well as to pay bills, make reservations, and more. Some
credit cards also offer rewards or cashback programs, which provide
incentives for using the card for certain types of purchases.
To use a credit card, a cardholder must first apply for and be approved for
a credit card account. Once approved, the cardholder will receive a
physical card and/or digital access to the credit card account, where they
can track their purchases, make payments, and manage their credit card
balance.
1.4.4.1.1 Types of Credit Card in India
There are several types of credit cards available in India, each designed to
cater to specific needs and lifestyles. Here are some of the most common
types of credit cards in India:
1. Rewards Credit Cards: These cards offer reward points for every
transaction that can be redeemed for various rewards like gift
vouchers, cashback, discounts, etc.
3. Travel Credit Cards: These cards are designed for frequent travelers
and offer benefits like air miles, lounge access, travel insurance, and
discounts on flights and hotels.
18
6. Business Credit Cards: These cards are designed for business owners Understanding
and offer benefits like rewards on business expenses, discounts on Personal Finance
office supplies, and expense management tools.
3. Builds credit score: Using a credit card responsibly can help build
your credit score, which is important when applying for loans or other
forms of credit.
5. Fraud protection: Credit cards offer fraud protection, and you are not
liable for unauthorized charges made on your card.
3. Fees: Credit cards may come with annual fees, late payment fees, and
other charges, which can add up and increase your debt.
19
4. Temptation to buy things you can't afford: Credit cards can tempt
Personal Financial
you to make purchases that you cannot afford, leading to financial
Planning
difficulties.
20
and other high-interest loans, into a single loan with a lower interest Understanding
rate and more manageable repayment terms. Personal Finance
21
5. Peer-to-Peer Lending Platforms: Peer-to-peer lending platforms
Personal Financial
connect borrowers with individual lenders, who provide loans at
Planning
competitive rates. These platforms can offer lower interest rates than
traditional lenders, but they also carry higher risk as the lenders may
not have the same level of regulation and oversight as banks and
NBFCs.
22
6. Lower interest rates: Secured consumer loans, such as home equity Understanding
loans or auto loans, can offer lower interest rates than unsecured loans, Personal Finance
making them a more affordable borrowing option.
2. Debt burden: Taking out too many consumer loans can lead to a high
debt burden, making it challenging to manage repayments and
potentially leading to financial difficulties.
6. Fees and charges: Some lenders may charge fees and charges
associated with consumer loans, such as loan origination fees or
prepayment penalties, which can add to the cost of the loan.
23
1. Vehicle purchases: Vehicles are often one of the most significant
Personal Financial
purchases a person will make. When planning a vehicle purchase, it is
Planning
essential to consider the cost of the vehicle, including the purchase
price, insurance, fuel costs, and maintenance expenses. It is also
crucial to determine how much you can afford to spend on a vehicle
and to consider financing options, such as auto loans or leases.
2. Real Estate: Real estate is a tangible asset that includes property such
as a house, apartment, or land. Investing in real estate can provide
rental income and appreciation in property value.
4. Bonds: Bonds are a type of debt security that represents a loan made
by an investor to a borrower. Bonds offer fixed income and can
provide portfolio diversification.
5. Mutual Funds: Mutual funds are investment vehicles that pool money
from multiple investors to purchase a portfolio of securities. Mutual
funds offer diversification and professional management.
9. Gold: Gold is a precious metal that has been used as a store of value
and a hedge against inflation. Gold can be purchased in the form of
bullion, coins, or exchange-traded funds.
24
new units. Crypto currency is volatile and requires careful research Understanding
and understanding. Personal Finance
13. Classic Cars: Classic cars are vintage or antique automobiles that are
considered to be valuable due to their age, rarity, or historical
significance. Classic cars can appreciate in value over time but require
careful research and maintenance.
5. Pay off Debt: Reducing or eliminating debt can free up more money
to invest in assets and provide greater financial security. Develop a
debt repayment plan to help pay off outstanding debts as quickly as
possible.
26
2. Purchase Insurance: Consider purchasing property insurance, Understanding
including homeowners or renters insurance, to protect against damage Personal Finance
or loss to your property. Liability insurance, such as umbrella
insurance, can protect against lawsuits and other legal liabilities.
1.6 EXERCISE
A. State whether the following statements are true or false
1. Personal finance planning refers to the process of managing resouces
of a company.
5. An individual can preserve and increase his wealth with proper tax
planning.
28
Answers: Understanding
Personal Finance
1 2 3 4 5 6 7
8. What are the different assets which are financed through consumer
finance?
D. Short Notes:
1. Personal Financial Statements
2. Types of Budgets in personal financial planning
3. Objectives of tax planning
4. Process of managing checking and savings accounts
5. Features of CIBIL.
6. ways to improve the credit score
7. Types of credit cards
8. Managing Property and Liability Risk
9. Managing Health Expenses
E. Exercise
1. Shashikant deposit ` 1,00,000 with a bank which pays 10 percent
interest compounded annually, for a period of 3 years. How much amount
he would get a maturity?
29
2. Mr Rahul has following investments in two banks
Personal Financial
Planning Particulars Bank of India HDFC
Year 1 2 3 4 5
30
2
RISK ANALYSIS & INSURANCE
PLANNING
Unit Structure
2.0 Objectives
2.1 Risk Analysis
2.2 Risk Management
2.0 OBJECTIVES
After reading this chapter, the learners will be able:
32
2.2 RISK MANAGEMENT Risk Analysis &
Insurance Planning
2.2.1 Meaning
Risk management is the process of identifying, evaluating, and controlling
potential risks in order to protect an individual's financial well-being. Risk
management in the context of personal financial planning (PFP) entails
identifying potential risks, assessing the likelihood and potential
consequences of each risk, and creating plans to control or lessen those
risks.
The protection of a person's financial assets and sources of income is the
main objective of risk management in PFP. This could entail taking
actions like getting insurance, diversifying investment holdings, setting up
an emergency fund, or making a contingency plan for unforeseen
circumstances.
For those who engage in PFP, effective risk management is crucial since it
enables them to safeguard their financial security and realise their long-
term financial objectives. Individuals can identify potential risks and
create ways to control or minimise them by adopting a proactive approach
to risk management, which will lessen the impact of unforeseen
occurrences on their financial status.
34
7. Review policies regularly: Insurance needs can change over time, so Risk Analysis &
it's important to regularly review insurance coverage and adjust Insurance Planning
policies as needed to ensure they continue to meet an individual's
needs.
35
Overall, insurance decisions can play a critical role in personal financial
Personal Financial
planning by protecting assets, managing risks, and supporting long-term
Planning
financial goals. It's important to carefully evaluate insurance needs and
options, and work with a financial advisor or insurance agent to ensure the
right coverage is selected for an individual's unique financial situation.
1. Coverage
Life Insurance provides coverage Non-Life Insurance provides
for the life of the insured. coverage for assets, liabilities, and
risks related to specific events.
2. Policy Period
Life Insurance policies are Non-Life Insurance policies are
generally long-term, covering the short-term, covering a specific
entire life of the insured. period usually a year.
3. Premium
Life Insurance premiums are Comparatively, non-life insurance
generally higher than non-life premium is lower than life insurance
insurance due to extended policy premium.
period.
4. Beneficiary
Life Insurance policies have a Non-Life Insurance policies do not
designated beneficiary who have a designated beneficiary.
receives the death benefit in case of
the insured's death.
5. Payments
Life Insurance policies pay the Non-Life Insurance policies pay the
benefit amount only in case of the benefit amount on the occurrence of
insured's death or on maturity of an insured event.
the policy.
6. Insurable Interest
In Life Insurance, the insured must Non-Life Insurance, the insured
have an insurable interest in the must have an insurable interest in
person whose life is being insured. the property or liability being
insured.
36
Risk Analysis &
7. Investment Component Insurance Planning
Life Insurance policies often have Non-Life Insurance policies usually
an investment component that do not have any investment
provides a savings element. component.
8. Tax Benefits
The premiums paid for Life Non-Life Insurance premiums like
Insurance policies are eligible for insurance of stock, building, assets
tax deductions under Section 80C are allowed as deduction in business
of the Income Tax Act. while, premium paid on health
insurance is allowed as deduction
under Section 80D of the Income
Tax Act.
9. Risks Covered
Life Insurance policies cover the Non-Life Insurance policies cover
risk of the insured's death or risks such as fire, theft, natural
disability disasters, and liability.
37
5. Auto insurance: Auto insurance provides coverage for damage to a
Personal Financial
vehicle and liability for damage or injury caused to others in an
Planning
accident. It is typically required by law in most states.
42
an individual's assets and ensuring financial security. Here are some Risk Analysis &
strategies for risk analysis and insurance planning for PFP Insurance Planning
b. Evaluate the level of risk: Once the potential risks have been
identified, the next step is to evaluate the level of risk associated with
each risk. This involves determining the probability of the risk
occurring and the potential financial impact it could have on an
individual's finances.
43
c. Determine the type of insurance needed: Based on the level of risk,
Personal Financial
an individual can determine the type of insurance coverage they need.
Planning
For example, if an individual owns a home, they may need
homeowners' insurance to protect against damage to the property.
Similarly, if an individual owns a car, they may need auto insurance to
protect against accidents or theft.
3. Covers final expenses: Life insurance can help cover the cost of
funeral and burial expenses, which can be a significant financial
burden for the family.
44
4. Offers tax benefits: Life insurance policies offer tax benefits, such as Risk Analysis &
tax-free death benefits and tax-deferred savings, which can help reduce Insurance Planning
the financial burden on the family.
2. Choose the right policy: There are several types of life insurance
policies available in the market. It is essential to choose the right one
that best suits your needs. For example, if you have dependents, a term
life insurance policy may be more suitable than a permanent policy.
8. Consider the Tax Planning: The premium paid for life insurance
policy is eligible for the deduction from the gross total income under
section 80C of the Income Tax Act, 1961
45
To summarize, risk analysis and insurance planning are critical to ensuring
Personal Financial
that you choose the right life insurance policy that meets your needs and
Planning
provides financial security to your loved ones in case of an unforeseen
event.
Need for Motor Insurance: The following points justify the Motor
Insurance Necessity.
1. Legal requirement: In many countries, it is mandatory to have motor
insurance to legally drive a vehicle on public roads. This is because
accidents can happen at any time, and insurance helps to provide
financial protection to both the driver and other parties involved in an
accident.
46
7. Covers theft: Motor insurance also provides coverage in case of theft Risk Analysis &
of the vehicle, which is a common occurrence in many countries. Insurance Planning
10. Helps reduce financial risk: Having motor insurance helps to reduce
the financial risk associated with owning and driving a vehicle, as the
cost of repairs or replacement of the vehicle can be substantial, and
insurance helps to mitigate this risk.
Factors to be considered while selecting a Motor Insurance Policy
1. Evaluate your driving habits: Before selecting a policy, assess your
driving habits to determine if you are a low-mileage driver or if you
drive frequently. This information will help you choose the appropriate
policy and avoid paying for coverage you do not need.
4. Consider the benefits: Look for policies that offer additional benefits
such as roadside assistance, rental car coverage, and discounts for safe
driving.
5. Check for discounts: Ask the insurer about any discounts you may be
eligible for, such as multi-car discounts, good driver discounts, and
loyalty discounts.
6. Read the fine print: Carefully read the policy documents to ensure
you understand the terms and conditions, coverage limits, and any
exclusions that may apply.
By following these strategies, you can make an informed decision and
select a motor insurance policy that fits your driving habits and budget.
47
2.2.8.4: Needs for Medical Insurance
Personal Financial
Planning 1. Medical insurance provides financial protection against the high cost
of medical treatment and healthcare services.
6. It offers peace of mind, knowing that you and your family are
protected against unexpected medical costs.
10. Medical insurance can help individuals and families maintain their
financial wellbeing by reducing the financial burden of medical costs
and expenses.
48
3. Network of Providers: Check the network of providers under each Risk Analysis &
policy to ensure that the providers you prefer are included in the Insurance Planning
network. You should also check the provider's reputation, credentials,
and experience.
10. Read the Fine Print: Read the policy documents carefully to
understand the terms and conditions, limitations, and exclusions of the
policy, and ensure that you are comfortable with them.
49
4. ___________ is not covered under motor insurance
Personal Financial
a. Loss by fire b. Theft
Planning
c. Health claim of driver d. Loss caused to another car in accident
True of False
1. Developing plans to mitigate the risk is the first step in risk
management.
2. Life insurance is a tool for risk management in personal financial
planning.
3. Comparing different motor car insurance plans of is waste of time.
4. Insurance plans are also useful to achieve long term plans.
5. Endowment plans are a type of life insurance policy that provides a
combination of insurance and savings.
Short Notes:
1. Objectives of risk management.
2. Role of Insurance decision in personal financial planning.
3. Different types of Life insurance policies.
4. Different types of Health Insurance Policy.
5. Strategies for risk analysis through general insurance.
50
3
RETIREMENT PLANNING &
EMPLOYEES BENEFITS
Unit Structure
3.0 Objectives
3.1 Introduction
3.2 Meaning of Retirement Planning
3.4 Sources of Retirement Planning:
3.5 Retirement Schemes:
3.6 Exercise
3.0 OBJECTIVES
After studying this chapter, learner will be able:
3.1 INTRODUCTION
One of the most significant life experiences that many of us will ever go
through is retirement. Realizing a pleasant retirement is a huge
undertaking that requires careful planning and years of perseverance, both
personally and financially. Even after reaching it, taking care of your
retirement is a constant duty that lasts well into your golden years. We all
want to be able to retire in luxury, but creating a good retirement plan may
be complicated and time-consuming, making the process seem downright
impossible. Even yet, with a little preparation, a manageable savings and
investment plan, and a long-term commitment, it is frequently possible to
complete it with less headaches (and financial anguish) than you may
anticipate.
51
planning is to achieve financial independence, so that the need to be
Personal Financial
gainfully employed is optional rather than a necessity.
Planning
The process of retirement planning aims to:
7. Lifestyle: Retirement planning can help you achieve the lifestyle you
want in retirement, whether that means traveling, pursuing hobbies, or
spending time with family and friends.
52
8. Debt: If you have debt, such as a mortgage or credit card debt, Retirement Planning
retirement planning can help you create a plan to pay off your debt & Employees
before you retire. Benefits
53
Personal Financial 3.4 SOURCES OF RETIREMENT PLANNING:
Planning
People can use a variety of retirement planning resources in India to assist
them in making retirement plans. Typical sources include:
1. Employee Provident Fund (EPF):The majority of employees in India
are required to participate in the government-sponsored EPF
retirement scheme. Both employers and employees make contributions
to the retirement fund, which is accessible upon retirement.
6. Interest rate: The EPS currently offers an interest rate of 8.15% per
annum.
7. Tax benefits: Contributions to the EPS are eligible for tax deductions
under Section 80C of the Income Tax Act, 1961.
Overall, the Employees Provident Scheme provides a reliable retirement
benefit to employees, helping them to secure their financial future.
55
Benefits of the EPF:
Personal Financial
Planning The Employees' Provident Fund (EPF) scheme in India has several
benefits for both employees and employers. Here are some of the key
benefits of the EPF scheme:
1. Retirement savings: The EPF scheme helps employees save for their
retirement. The funds accumulated in the EPF account can provide a
steady source of income in retirement.
= 12% of ` 2,48,000
= 29,760
56
Note 3: Employee’s contribution to RPF is not taxable. It is eligible for Retirement Planning
deduction under section 80C. & Employees
Benefits
The Table below Shows the Interest on EPF over the years.
Annual
Annual Interest Rate (%) on EPF
Financial Interest 9.00%
8.80%
Year Rate (%)
8.60%
2017-18 8.55%
2018-19 8.65%
2019-20 8.50%
2020-21 8.50%
2021-22 8.10%
2022-23 8.15%
57
When an employee retires or resigns, the accumulated balance is paid to
Personal Financial
him. In the event of the employee's death, the same amount is paid to his
Planning
legal heirs.The provident fund is an important source of small savings for
the government. Hence, the Income-tax Act, 1961 gives certain deductions
on savings in a provident fund account.
Types of
Employees'
Provident Funds
Eligible for
Employee’s Eligible for
Not eligible for deduction deduction
Contribution deduction u/s 80C
u/s 80C
•Employee’s contribution
is not taxable.
Exemptu/s •Interest on Employee’s
10(12)subject to contribution is taxable
Amount with drawn on specified conditions under the head of “Income Exempt u/s
retirement/termination mentioned in the from Other Sources”. 10(11)
chart below
•Employer’s contribution
(*#*) and interest ther eon is
taxable as “Profit in lieu of
salary” u/s 17(3).
Note: Salary for this purpose means basic salary and dearness allowance -
if provided in the terms of employment for retirement benefits and
commission as a percentage of turnover.
58
Illustration 01: Retirement Planning
& Employees
Mr. Ashwin retires from service after 22 years of service. Following are
Benefits
the details of his income and investments for the previous year 2021-22:
Particulars Amount
(`)
Out of the amount received from the unrecognised provident fund, the
employer’s contribution was ` 2,20,000 and the interest thereon `50,000.
The employee’s contribution was ` 2,70,000 and the interest thereon `
60,000. What is the taxable portion of the amount received from the
unrecognized provident fund in the hands of Mr. A for the assessment year
2022-23?
Solution:
Taxable portion of the amount received from the Unrecognised Provident
Fund in the hands of Mr. A for the A.Y. 2022-23 is computed hereunder:
Particulars ` `
Note: Since the employee is not eligible for a deduction under section 80C
at the time of contribution to the URPF, the employee's share received
from the URPF is not taxable at the time of withdrawal because this
amount has already been taxed as his salary income.
59
Illustration 02:
Personal Financial
Planning What would your response be if the fund in the preceding illustration was
a recognised provident fund?
Solution:
As the fund is recognised provident fund and the maturity occurs after 22
years of service (i.e. a period more than 5 years), the entire amount
received on the maturity of the RPF will be tax-free.
Illustration 03:
Mr. Bharat is working in Sheena Ltd. and has provided with the details of
his income for the A.Y. 2022-23. You are required to compute his gross
salary from the details given below:
Bonus `60,000
Gratuity `50,000
60
Solution: Retirement Planning
& Employees
Computation of Gross Salary of Mr. B for the A.Y.2020-21
Benefits
Particulars ` `
Bonus 60,000
Working Note:
Note 1: Gratuity received during service is fully taxable.
Note 2: Employers contribution to RPF is exempt up to 12% of salary.
Salary for the Purpose of calculation of = 12% of [Basic Salary +
Dearness Allowance forming part of retirement benefits + Commission
based on turnover]
= 12% of ` 2,48,000
= 29,760
Note 3: Employee’s contribution to RPF is not taxable. It is eligible for
deduction under section 80C.
61
(*#*)Summary for Exemption of RPF:
Personal Financial
Planning
If Yes = Fully
No
Exempt
Is the entire balance standing to the Is the entire balance standing to the
credit of the employee transferred to credit of the employee transferred to his
his individual account in any RPF NPS account referred to in section 80CCD
maintained by his new employer? and notified by the Central
62
3. Tax benefits: Contributions made to the PPF account are tax- Retirement Planning
deductible under Section 80C of the Income Tax Act, up to a & Employees
maximum of Rs. 1.5 lakh per year. Additionally, the interest earned Benefits
on the PPF account is tax-free.
Benefits of PPF:
Public Provident Fund, also known as PPF, is a long-term savings
programme introduced by the Indian government. It is a popular
investment choice among people because it provides investors with a
number of advantages. The following are a few advantages of PPF:
1. Tax benefits: Under Section 80C of the Income Tax Act, 1961,
contributions made to PPF are eligible for tax deductions. Both the
accrued interest and the maturity revenues are tax-free.
63
5. Safety: PPF is a safe investment option as it is backed by the
Personal Financial
government. It offers guaranteed returns, making it a low-risk
Planning
investment option.
7. Loan facility: PPF offers a loan facility to account holders after the
third year of opening the account. The loan amount can be up to 25%
of the balance in the account at the end of the second year preceding
the year in which the loan is applied for.
Annual
Financial Interest Annual Interest Rate
8.00%
Year Rate (%) 7.00%
6.00%
2013-14 7.10% 5.00%
4.00%
2014-15 7.10% 3.00%
2.00%
2015-16 7.10% 1.00%
0.00%
2016-17 7.10%
2017-18 7.10%
Annual Interest Rate
2018-19 7.10%
2019-20 7.10%
2020-21 7.10%
2021-22 7.10%
2022-23 7.10%
64
Tax Treatment of Contribution to different Category of Provident Retirement Planning
Fund & Employees
Benefits
Particulars Public Provident Fund
Amount withdrawn on
Fully exempt u/s 10(11)
retirement/termination
Illustration 04:
Mr. Rohit is working for MI Ltd. The details of the emoluments received
and investments made by him are as follows:
Particulars Amount
Solution:
65
Working Note 1:
Personal Financial
Planning 80C - Contribution to PPF (Lower of:)
a. Actual Amount Paid 1,80,000
b. Maximum Amount Allowed under 80C 1,50,000
Lower 1,50,000
4. Tax advantages: Under Section 80C of the Income Tax Act of 1961,
contributions made to the Superannuation Fund are eligible for tax
deductions. Both the accrued interest and the maturity revenues are
tax-free.
5. Vesting term: After a vesting period, which is typically five years, the
employee is qualified to receive Superannuation Fund benefits.
66
8. Estate Planning: The Superannuation Fund provides estate planning Retirement Planning
advantages by allowing employees to name a nominee to receive & Employees
benefits in the case of their death. Benefits
In general, Superannuation Funds give employees a dependable retirement
benefit, assisting them in securing their financial future.
2. Tax benefits: Under Section 80C of the Income Tax Act of 1961,
contributions made to the Superannuation Fund are eligible for tax
deductions. Both the accrued interest and the maturity revenues are
tax-free.
68
Employee’s Contribution: An employee can claim a deduction under Retirement Planning
Section 80C for funds invested in an approved scheme. & Employees
Benefits
Employer’s Contribution: The government allows an exemption of
` 1,50,000/- per employee per year. The exemption is only provided
by the government if the employer contributes to the specified funds.
The contribution may exceed `1,50,000/- in the specified
circumstances. In such cases, the balance would be taxable in the
employee's hands.
3. The payment has been made to the employee's account via transfer
under the pension scheme referred to in section 80CCD and notified
by the Central Government; or
3.5.4 Gratuity:
Meaning: A gratuity is the sum of money that an employer gives to a
worker in appreciation for the services that the worker has provided to the
business. The gratuity sum, however, is only granted to employees who
have worked for the business for five years or longer. It is governed by the
Payment of Gratuity Act, 1972.
If an employee becomes handicapped in an accident or due to a disease,
they are eligible to receive their gratuity before the five-year mark. The
amount of your gratuity is primarily based on your most recent income
and the number of years you have worked for the company.
69
Needs for Gratuity:
Personal Financial
Planning As per the Payment of Gratuity Act, 1972, an employee is eligible for
gratuity if he/she has completed five years of continuous service with the
same employer. Gratuity is payable on retirement, resignation,
superannuation, death, or disablement due to accident or illness.
70
2. Employee Retention: Gratuity encourages employees to stay with the Retirement Planning
same employer for a longer period of time by ensuring that they will be & Employees
rewarded for their loyalty and hard work. Benefits
71
Category – I: Defence Service or Government Employee – Fully
Personal Financial
Exempt
Planning
Category – II: Covered by the Payment of Gratuity Act, 1972
Gratuity is exempt from tax to the extent of least of the following:
(a) ` 20,00,000
(b) Gratuity amount actually received
(c) 15 days’ salary based on last drawn salary for each completed year of
service or part thereof in excess of 6 months
Note: Salary for this purpose means basic salary and dearness
allowance. No. of days in a month for this purpose, shall be taken as
26.
Category – III: Not Covered by the Payment of Gratuity Act, 1972
(a) ` 20,00,000
(b) Gratuity amount actually received
(c) Half month’s salary (based on last 10 months’ average salary
immediately preceding the month of retirement or death) for each
completed year of service (fraction to be ignored)
Note: Salary for this purpose means basic salary and dearness
allowance, if provided in the terms of employment for retirement
benefits, forming part of salary and commission which is expressed as
a fixed percentage of turnover.
Learners must also note the following points:
Any gratuity you receive while you are working is completely taxable.
Illustration 05:
Mr. Ravi retired on 15.06.2022 after completion of 26 years 8 months of
service and received gratuity of ` 9,00,000. At the time of retirement, his
salary was:
Solution:
Taxable Gratuity -
C. Government Employee
Gratuity Received 9,00,000
Taxable Gratuity -
73
Working Note 1
Personal Financial
Planning A. Covered by Payment of Gratuity Act
Gratuity is Exempt to the least of the following:
Working Note 2
A. Not Covered by Payment of Gratuity Act
Gratuity is Exempt to the least of the following:
1. Actual Amount Received 9,00,000
2. Maximum Allowed 20,00,000
3. 1/2 x Average Salary x No. of Years of Employment 8,19,000
(1/2 x 63,000 x 26)
Amount of Exemption 8,19,000
Average Salary
Salary = Basic + DA (Terms) + Fixed Percentage of Commission on
Turnover
Basic = 50,000 p.m.
DA (Terms) = (20,000 x 60%) = 12,000 p.m.
74
Fixed Percentage of Commission on Turnover = (12,00,000 x 1%) = Retirement Planning
12,000 p.a. & Employees
Benefits
Average Salary = ((50,000 x 10) + (12,000 x 10) + (12,000/12 x 10))/10
63,000
No. of Years of Employment = 26 years and 8 months
No. of Years of Employment = 26 years
Working Note 3
Gratuity received by the Government Employee after retirement is
exempted from tax.
Gratuity
oReceived oReceived
During During
Employment Retirement
Government Non
Fully
Government
Taxable Employee
Employee
Fully Exempt
Covered Not Covered
Under POGA Under POGA
oExemption is oExemption is
Least of the three: Least of the three:
oa. Maximum
20,00,000 oa. Maximum
ob. Actual Amount 20,00,000
Received ob. Actual Amount
oc. 15 days' salary Received
(based on last drawn
salary) for every
oc. Half month salary
completed year of (based on avg of last 10
service or part in months salary) for
excess of 6 months every completed year
(No. of days in a of service
month to be taken as
26)
(a) taking the compensation pension to which he may be entitled for the
service he had rendered, or
77
deferred, which means that the earnings are not taxed until the funds
Personal Financial
are withdrawn.
Planning
3. Defined benefit vs. defined contribution pension plans: There are two
types of pension plans: defined benefit and defined contribution.
Defined benefit plans pay a set amount to the employee upon
retirement, whereas defined contribution plans allow employees to
contribute to their own retirement savings while also allowing the
employer to contribute.
4. Vesting: The period of time an employee must work for an employer
before becoming eligible for pension plan benefits is referred to as
vesting. Vesting periods differ depending on the plan and the
employer.
78
5. Guaranteed income: Defined benefit pension plans provide a Retirement Planning
guaranteed income stream in retirement, which can provide retirees & Employees
with peace of mind and financial stability. Benefits
Illustration 06:
Mr. Mahadev retired on 01.10.2022and was receiving ` 10,000 p.m. as
pension starting from 31.10.2022. On 01.02.2023, he commuted 60% of
his pension and received ` 9,00,000 as commuted pension. You are
required to compute his taxable pension assuming:
79
1. He is a government employee.
Personal Financial
2. He is a private sector employee, receiving gratuity of 5,00,000 at the
Planning
time of retirement.
3. He is a private sector employee and is not in receipt of gratuity at the
time of retirement.
Solution:
Pension
Uncommuted
From Oct to Jan (10,000 x 4m) 40,000
From Feb to Mar (10,000 x 40% x
2m) (WN. 1) 8,000 48,000
Commuted
Received 3,00,000
Less: Exempt (WN. 2) (3,00,000) -
Pension
Uncommuted
From Oct to Jan (10,000 x 4m) 40,000
From Feb to Mar (10,000 x 40% x 2m)(WN. 1) 8,000 48,000
Commuted
Received 9,00,000
Less: Exempt (WN. 3) (5,00,000) 4,00,000
80
Case III: Non-Government Employee (Gratuity is not received) Retirement Planning
& Employees
Particulars Amount Amount Benefits
Pension
Uncommuted
From Oct to Jan (10,000 x 4m) 40,000
From Feb to Mar (10,000 x 40% x 2m)(WN. 1) 8,000 48,000
Commuted
Received 9,00,000
Less: Exempt (WN. 4) (7,50,000) 1,50,000
WN. 1
Since the Pension is commuted for 60%, after 01.02.2023 only 40% of
uncommuted pension will be received by the Assessee in the future.
WN. 2
Commuted Pension received by the government employee is fully
exempted.
WN. 3 Exemption is calculated as below when gratuity is received:
1/3 x (Amount of Commutation/% of Commutation)
= 1/3 x 900000 ÷ 60%
= 1/3 x 15,00,000
= 5,00,000
WN. 4 Exemption is calculated as below:
= 1/2 x (Amount of Commutation/% of Commutation)
=1/2 x 9,00,000 ÷ 60%
= 1/2 x 15,00,000
= 7,50,000
81
Personal Financial Pension
Planning
Commuted Uncommuted
Non Government
Government Employee Fully Taxable
Employee
82
5. Legal planning: It includes estate planning, wills, and other legal Retirement Planning
issues that retirees may require. & Employees
Benefits
Financial planners, retirement counsellors, and social workers are among
the professionals who can provide post-retirement counselling. It can be
delivered one-on-one or as part of a group programme. Post-retirement
counselling can assist retirees in navigating the many changes and
challenges that come with retirement and maximising their retirement
years.
83
Personal Financial 3.6 EXERCISE
Planning
A. Choose the most appropriate alternative:
1. Which of the following is not a tool for retirment planning?
a. Contribution to Provident Fund
b. Contribution to pension funds
c. Contribution to Public Provident fund
d. Contribution to political party fund
2. Partial withdrawal from PPF is allowed after __________ years.
a. 3 b. 4 c. 5 d. 6
3. Maximum tax benefit under EPF is _________.
a. 1,00,000 b. 1,50,000 c. 2,00,000 d. 2,50,000
4. In case of recognised provident fund, interest credited in excess of
_________ is taxable.
a. 8% b. 9.5 c. 10% d. 12%
5. For the purpose of employee covered by Payment of Gratuity Act,
1972, no. of days in the month is considered as:
a. 25 days b. 26 days c. 30 days d. 31 days
B. True or False
1. Retirement planning can be done at young age.
2. Withdrawal from RPF is not taxable.
3. Only government employee can contribute towards the PPF
4. The company can contribute maximum of 10% of employee's base
salary and dearness allowance for superannuation.
5. Gratuity received by government employee is fully exempt from tax.
1. True; 2. False; 3. False; 4. False; 5. True
C. Answer in Brief
1. What are the needs for retirement planning?
2. What are the different types of pension plans?
3. What is post retirement counselling? State the key features of it.
4. What are the benefits of superannuation funds?
D. Short Notes
1. Process of development of retirement plan.
2. Sources of retirement planning.
3. Benefits of EPF
4. key features of the PPF scheme
5. Key features of pension fund.
84
4
INVESTMENT PLANNING
Unit Structure
4.0 Objective
4.1 Meaning of Risk
4.3 Risk Return Analysis
4.4 Investment Planning
4.5 Asset Allocation Investment Strategies
4.6 Portfolio Construction and management process
4.0 OBJECTIVE
After studying this unit, you will be able:
To identifying the various types of risks associated with a person;
To comprehend the various methods for measuring and managing
risks;
To become acquainted with risk management;
To examine the role and significance of financial statements in
financial planning.
To define the term "investment" and define the various types of
investments;
To introduce the concept of risk and return;
To determine an asset's expected return and describe risk-free and
risky assets.
Types of Risks:
Systematic risk and unsystematic risk are two different types of risks that
investors face when investing in financial markets.
A. Systematic Risks: Systematic risk, also known as market risk, is a risk
that affects the entire market or economy. It is not unique to any one
company or investment, but rather to the market as a whole. Changes in
interest rates, political instability, natural disasters, and recessions are all
examples of systematic risk.
85
Different types systematic risk:
Personal Financial
Planning 1. Interest rate risk: This type of risk arises when interest rates change,
which can impact the prices of bonds and other fixed-income securities.
For example, as interest rates rise, bond prices fall, and vice versa.
Risk Measurement:
The process of quantifying or estimating the level of risk associated with a
specific activity or investment is referred to as risk measurement.
Assessing the likelihood and potential impact of potential risks, as well as
the effectiveness of risk management strategies in reducing or mitigating
those risks, is part of this process. Risk measurement is an important
86
component of risk management because it enables individuals and Investment Planning
organisations to identify and assess potential risks, as well as develop
appropriate risk mitigation or risk management strategies. Organizations
can make informed decisions and take action to minimise potential losses
and improve overall performance by measuring and analysing risks.
1. Standard deviation ( ): It is a measure of how much the values in a
set of data deviate from the mean value. It is calculated by taking the
square root of the variance. A higher standard deviation indicates greater
variability in the data. Mathematically it can be represented as
OR
87
7. Sensitivity analysis: Sensitivity analysis involves assessing the
Personal Financial
potential impact of changes in key variables or assumptions on the overall
Planning
risk of an activity or investment. This may involve conducting a "what-if"
analysis to evaluate the impact of changes in interest rates, market
conditions, or other factors on the overall risk level.
Solution 01:
Year Return Deviation Squared
Deviation
x x–x` (x - x `)2
2019 10,000 3,600 1,29,60,000
2020 5,000 (1,400) 19,60,000
2021 (3,000) (9,400) 8,83,60,000
2022 12,000 5,600 3,13,60,000
2023 8,000 1,600 25,60,000
32,000 13,72,00,000
x ` = 32,000/5
x ` = 6,400
Variance 2,74,40,000
88
Investment Planning
steps:
1. Calculate the average return: To calculate the average return, we add up
all the returns and divide by the number of years. In this case, the average
return is:
Average Return = (10,000+5,000+(3,000)+12,000+8,000)/5 = 6,400
2. Calculate the deviation of each return from the average return: To
calculate the deviation of each return from the average return, we subtract
the average return from each return.
10,000 0.20
20,000 0.30
60,000 0.10
80,000 0.20
20,000 0.20
89
Solution:
Personal Financial
Planning
Project X
D = x ` -
A B C=AxB E = D^2 F=BxE
A
Expected
Cash Flow Probability Cash x-x` (x - x `)2 P.(x - x `)2
Inflows
10,000 0.20 2,000 (24,000) 57,60,00,000 11,52,00,000
20,000 0.30 6,000 (14,000) 19,60,00,000 5,88,00,000
60,000 0.10 6,000 26,000 67,60,00,000 6,76,00,000
80,000 0.20 16,000 46,000 2,11,60,00,000 42,32,00,000
20,000 0.20 4,000 (14,000) 19,60,00,000 3,92,00,000
x ` =
1.00 70,40,00,000
34,000
Variance =70,40,000
Standard Deviation=
=
= 26,533.00
Coefficient of Variation =
= = 0.78
1 2,00,000 0.75
2 1,40,000 0.70
3 1,30,000 0.65
4 1,20,000 0.60
5 80,000 0.65
90
The investment scheme requires immediate invested of ` 3,00,000. Investment Planning
Kindly Suggest to Mr. Dubey, the investor, whether the investment
scheme is worth investing of not? Assume discounting factor to be 15%.
Solution:
A B C D E=CxD F=BxE
Since the net present value is positive, Mr. Dubey should invest in the
scheme.
Illustration 04:
Rajesh Ltd. is considering launching a new product line, and they have
estimated the probabilities of three possible outcomes: success, moderate
success, and failure. The following table shows the estimated probabilities
and the corresponding payoff for each outcome:
You are required to calculate the expected value of the new product line,
we can use the following formula:
Expected value = (Probability of success x Payoff for success) +
(Probability of moderate success x Payoff for moderate success) +
(Probability of failure x Payoff for failure)
91
Expected value = (0.4 x 100,000) + (0.3 x 50,000) + (0.3 x -20,000)
Personal Financial
Planning Expected value = 40,000 + 15,000 - 6,000
Expected value = 49,000
Therefore, the expected value of the new product line is ` 49,000. This
means that, on average, the company can expect to earn ` 49,000 in profit
from the new product line.
OR
A B C D=BxC
49,000
2. Identify the risks: Investors must then identify the risks associated with
the investment, which may include market risk, credit risk, liquidity
risk, and operational risk.
3. Assess the level of risk: Investors then assess the level of risk
associated with the investment by employing techniques such as
probability analysis, scenario analysis, and stress testing.
92
5. Make an investment decision: Finally, investors make an informed Investment Planning
investment decision based on the risk-return analysis, taking into
account both the potential return and the level of risk associated with
the investment.
Overall, risk-return analysis is an important tool for investors to use when
evaluating investments and making informed decisions that balance
potential returns with risk. It assists investors in identifying investments
with the potential for higher returns while managing risk in order to
achieve their financial goals.
93
7. Diversification: Investing in a mix of stocks from different sectors and
Personal Financial
industries can help reduce risk and exposure to any one company or
Planning
sector.
By considering these factors, investors can make informed decisions about
investing in stocks that align with their risk tolerance, investment goals,
and financial situation.
Investing in stocks can offer both advantages and disadvantages. Here are
some of the key pros and cons to consider:
Advantages:
1. High potential returns: Investing in stocks has the potential for high
long-term returns, especially if you invest in companies with strong
growth prospects or pay dividends. Stocks have historically outperformed
other asset classes such as bonds and cash over the long term.
2. Liquidity: Because stocks can be bought and sold easily, they are a
relatively liquid investment. If you need to access your money quickly,
you can usually sell your shares quickly.
3. Diversification: By investing in stocks, you can diversify your portfolio
and reduce risk. You can spread your investment risk and potentially
improve your returns by owning shares in a variety of companies across
different industries and regions.
4. Ownership: When you buy stocks, you become a part-owner of the
company. This gives you a say in company decisions as well as the
opportunity to profit from its profits.
Disadvantages:
1. Volatility: Stock prices can fluctuate quickly due to a variety of factors
such as economic conditions, political events, and company performance.
This can make predicting your returns and timing your trades difficult.
2. Risk: Investing in stocks is risky because there is always the possibility
of losing some or all of your money. Stock prices can be influenced by a
number of factors, including market conditions, economic recessions, and
company-specific risks.
3. Difficulty: Investing in stocks can be difficult, particularly if you are
unfamiliar with financial markets or accounting principles. It can be
difficult to determine which companies are likely to perform well, and
research and analysis can take time.
4. Fees and taxes: When investing in stocks, you may be required to pay
brokerage fees, capital gains taxes, and dividend taxes. These costs can eat
into your returns and reduce your investment's overall profitability.
94
Overall, investing in stocks can be a good long-term way to grow your Investment Planning
wealth, but it's critical to understand the risks and potential drawbacks
before you invest. If you're new to investing or have questions about your
investment strategy, it's also a good idea to seek the advice of a financial
professional.
Advantages:
1. Income: Bonds can provide a consistent stream of income in the form of
interest payments, which can be particularly appealing to investors seeking
a source of passive income.
2. Diversification: Bonds can help diversify your portfolio, reducing risk.
When stocks and bonds are combined in a portfolio, the bond investments
can help offset stock losses.
3. Capital preservation: Bonds are generally regarded as less risky than
stocks, and they can aid in capital preservation during market downturns.
4. Protection against inflation: Some bonds, such as Treasury Inflation-
Protected Securities (TIPS), are designed to provide inflation protection by
adjusting their principal value in response to changes in the consumer
price index.
Disadvantages:
1. Low returns: Bonds typically provide lower long-term returns than
stocks, which can be a disadvantage for investors looking to maximise
their returns.
95
2. Interest rate risk: As previously stated, bonds are vulnerable to interest
Personal Financial
rate risk, which can lead to losses if interest rates rise.
Planning
3. Credit risk: Bonds issued by lower-rated companies are more likely to
default, resulting in investor losses.
4. Inflation risk: Bonds are subject to inflation risk if the rate of inflation
exceeds the bond's interest rate, which can erode the investment's
purchasing power over time.
Overall, investing in bonds can be a good way to diversify your portfolio
and generate income, but before you invest, you should carefully consider
the key factors, advantages, and disadvantages. A financial advisor can
assist you in determining whether bonds are a good fit for your personal
financial plan and can recommend specific bond investments that
correspond to your goals and risk tolerance.
Meaning:
A mutual fund is a type of investment vehicle that pools money from
multiple investors in order to buy a diverse portfolio of stocks, bonds, or
other assets. A professional investment manager manages the fund,
deciding which assets to buy and sell in order to meet the fund's
investment objectives.
1. Investment objectives: Different mutual funds have varying investment
objectives, such as income generation, capital appreciation, or a
combination of the two. It is critical to select a mutual fund that aligns
with your own investment objectives.
2. Fees: Mutual funds charge management and administration fees, which
vary greatly between funds. These fees can reduce your returns, so it's
critical to understand and compare the fees of various funds.
3. Performance history: When selecting an investment, the performance of
a mutual fund can be an important factor to consider. To evaluate the
fund's performance, examine its historical returns over various time
periods and compare them to benchmarks.
4. Risk level: The risk level of mutual funds varies depending on the assets
they invest in and their investment objectives. It is critical to select a
mutual fund that matches your risk tolerance.
5. Fund manager: The fund manager is in charge of making investment
decisions for the fund. When selecting a mutual fund, it is critical to
consider the fund manager's experience and track record.
96
Advantages: Investment Planning
1. Diversification: When you invest in mutual funds, you can diversify
your portfolio across a wide range of assets, which can help reduce risk.
2. Professional management: Mutual funds are managed by experienced
investment professionals with the knowledge and expertise to make sound
investment decisions on the fund's behalf.
3. Liquidity: Because mutual funds are easily bought and sold, they are a
relatively liquid investment.
4. Availability: Because mutual funds are widely available and can be
purchased through most brokerage accounts, they are a viable investment
option for individual investors.
Disadvantages:
1. Management and administration fees: Mutual funds charge management
and administration fees, which can eat into your returns and reduce the
overall profitability of your investment.
2. Limited control: When you invest in a mutual fund, you are entrusting
the fund manager with your investment decisions. This can make it
difficult to make individual investment decisions.
3. Lack of transparency: Mutual funds can be complex investment
vehicles, making it difficult to understand how your money is being
invested.
4. Market risk: Mutual funds, like all investments, are subject to market
risk, which means that their returns can be influenced by economic
conditions, political events, and other factors beyond your control.
Overall, investing in mutual funds as part of your personal financial plan
can be a good way to achieve your financial goals. However, before
investing in any particular fund, it's critical to carefully consider the key
factors, benefits, and drawbacks, and to seek the advice of a financial
professional if you're new to investing or unsure about your investment
strategy.
97
hedge against future price movements or to speculate on underlying asset
Personal Financial
price movements.
Planning
2. Options: Options contracts grant the buyer the right, but not the
obligation, to buy or sell an underlying asset at a future date and price.
They are frequently used for hedging.
3. Swaps: Swaps are contracts between two parties in which cash flows
are exchanged based on the performance of an underlying asset or
benchmark. They are frequently used to manage interest rate, currency,
and credit risk.
Overall, as part of a personal financial plan, derivatives can be an effective
way to manage risk, gain exposure to different markets, and generate
income. They do, however, carry a high level of risk and complexity, and
it is critical to carefully consider the key factors, benefits, and drawbacks
before investing in any particular derivatives contract.
Important considerations:
1. Risk tolerance: Derivatives are complex financial instruments with high
risk. Before investing in derivatives, you should think about your risk
tolerance and investment objectives.
2. Market understanding: Derivatives necessitate a thorough understanding
of the underlying assets as well as market dynamics. Before investing in
derivatives, it is critical to have a thorough understanding of the markets
in which you intend to invest.
3. Volatility: Derivatives are frequently used to manage risk and volatility,
but they can also be volatile themselves. Before investing in derivatives, it
is critical to understand the potential volatility of the underlying assets and
markets.
4. Margin requirements: Derivatives trading frequently necessitates
margin, which is money that the investor must put up as collateral. It's
critical to understand the margin requirements and how they might affect
your investment returns.
5. Counterparty risk: Derivatives contracts involve two parties, and there
is always the possibility that one of them will fail to meet their obligations.
When investing in derivatives, it is critical to select reputable
counterparties and understand counterparty risk.
Advantages:
1. Risk management: Derivatives can be used in a portfolio to manage risk
and volatility by providing a way to hedge against price movements in
underlying assets.
2. Leverage: Derivatives can offer leverage, allowing investors to gain
exposure to a market or asset with a small initial investment.
98
3. Diversification: Derivatives can be used to gain exposure to a wide Investment Planning
range of markets and assets, allowing for diversification.
4. Income generation: Through option writing and other strategies,
derivatives can be used to generate income.
1. High risk: Derivatives are complex financial instruments with a high
degree of risk. Investing in derivatives can lead to substantial losses.
2. Complexity: Derivatives are sophisticated financial instruments that
necessitate a thorough understanding of the underlying assets as well as
market dynamics. For inexperienced investors, they can be difficult to
grasp.
3. Margin requirements: Margin is frequently required in derivatives
trading, which can result in additional costs and increase the risk of loss.
4. Counterparty risk: Derivatives contracts involve two parties, and there
is always the possibility that one of them will fail to meet their obligations.
This can lead to substantial losses for investors.
5. Lack of transparency: Derivatives markets can be opaque and opaque,
making it difficult for investors to determine the true value of their
investments.
Overall, as part of a personal financial plan, derivatives can be an effective
way to manage risk, gain exposure to different markets, and generate
income. They do, however, carry a high level of risk and complexity, and
it is critical to carefully consider the key factors, benefits, and drawbacks
before investing in any particular derivatives contract.
Key factors:
1. Location: A property's location is an important factor in determining its
value and potential for income generation. When evaluating a property, it
is critical to consider factors such as proximity to amenities,
transportation, and schools.
2. Property type: The potential for income generation and appreciation
varies depending on the type of property, such as single-family homes,
multi-family properties, and commercial properties.
3. Financing: Real estate investments frequently necessitate large sums of
money, and financing options such as mortgages and loans can have an
impact on the overall return on investment.
99
4. Property management: Managing a property, which includes finding
Personal Financial
tenants, handling maintenance, and collecting rent, can be time-consuming
Planning
and necessitates specialised skills and knowledge.
5. Market trends: Real estate markets can be cyclical, so it's critical to stay
current on local market conditions and trends when investing in real estate.
Advantages:
1. Income generation: Rental income from real estate investments can
provide a consistent source of passive income.
2. Capital appreciation: The value of real estate can increase over time,
providing the opportunity for capital gains when the property is sold.
3. Inflation hedge: Because rental income and property values can rise in
lockstep with inflation, real estate can be used as an inflation hedge.
4. Tax advantages: Real estate investors can take advantage of tax breaks
such as mortgage interest and depreciation.
5. Tangible asset: Real estate investments provide a tangible asset that can
be seen and touched, thereby providing security and stability.
Disadvantages:
1. Capital requirements: Real estate investments frequently necessitate
large sums of money, which can make them inaccessible to some
investors.
2. Market volatility: Real estate markets can be subject to cyclical trends,
which can affect a property's value and income potential.
3. Property management: Managing a property takes time and requires
specific skills and knowledge, which can be difficult for some investors.
4. Liquidity: Real estate investments can be illiquid, which means they can
be difficult to convert into cash quickly.
5. Risk: There is inherent risk in real estate investments, including the
possibility of tenant vacancies, property damage, and legal liabilities.
Overall, as part of a personal financial plan, investing in real estate can
provide a source of consistent income as well as the potential for capital
appreciation. However, before making a real estate investment, it is
critical to carefully consider the key factors, advantages, and
disadvantages, as the capital requirements and potential risks can be
significant.
103